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Fed may not tighten credit until next year, experts say

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The US Federal Reserve’s decision yesterday to hold its key interest rate at zero, coupled with its cautious comments and new focus on the possible impact of external factors, means the cost of central bank credit may stay put until next year, according to asset managers and economists.

Although most expected a rate rise to happen in December, many analysts also scrutinised comments by Fed chair Janet Yellen following the decision, which were seen as indicating a more doveish attitude to raising interest rates, as well as a downward revision in its long-term rate outlook.

At its meeting yesterday, the Federal Open Market Committee (FOMC) left the Fed funds rate unchanged at 0.00-0.25%.

At AXA Investment Managers (AXA IM), senior economist David Page said it was important the Fed lowered its long-term rate outlook to 1.8-2.2% from 2-2.3%.

“The Fed continues to expect a December hike, as signalled by its dots chart,” he said.

“However, there were otherwise doveish elements to (the) announcement, including a lowering of short-run growth and inflation forecasts and long-term growth, unemployment and the Fed funds rate projections.”

He said AXA IM believed the FOMC was likely to hike in December, particularly if the Q3 employment cost index shows some signs of revival.

“In the interim, we expect speculation to rise that the Fed will not tighten policy this year,” he said.

In a global research report, Bank of America Merrill Lynch said the Fed’s decision was about as doveish as it could be for equity investors, with the committee members having committed to watch international developments.

“Similar to deferral of Fed tapering in 2013, we see this as supportive to equities given the de-risking already undertaken,” it said.

Peter O’Flanagan, head of foreign exchange trading at ClearTreasury, also noted the way the Fed statement referred to worries about the slowdown in the external environment.

“Previously, the Fed had indicated it would be focused on the domestic economy when making decisions around rate hikes, but things have certainly changed,” he said.

“Now, it is looking at events in China and other emerging markets and their potential impact on global growth.”

Although the Fed maintained it still expected to hike this year, O’Flanagan said December was the only real possibility for this to happen.

He said he saw the first quarter of next year as a more realistic target.

Lee Ferridge, head of North American macro strategy at State Street Global Markets, said the Fed’s international focus had increased the importance of dollar strength, with the US currency being “the doorway by which the global economy affects the domestic one.”

“Now it’s a waiting game again, and every upcoming meeting is on the table so long as data and conditions can justify a move,” he said.

“However, there is no guarantee the conditions will be satisfactory ahead of the end of 2015.”

Meanwhile, Rick Rieder, CIO of fundamental fixed income at BlackRock, said there were strong signals that a rate hike before the end of the year was very probable.

Rieder said the timing of the next increase was much less important than the pace of credit tightening, and that the Fed had already said it would be measured in its approach.

“It is very clear the Fed’s monetary policy this upcoming cycle will be nothing like the historic tightening cycles of the past in terms of the consistency of movement at each meeting, or the long-term trajectory of significant rate rises,” he said.

Felix Wintle, head of US equities at Neptune Investment Management, also said he expected a rate cut this year.

“At Neptune, we are still confident the Fed will raise rates in 2015 and believe December is now the most likely time for this,” he said.

Even though the language accompanying yesterday’s decision was doveish, rate rises may come quicker than the market expects, he said.

Rising rates will change the investment landscape, he said, with a rising rate environment creating winners and losers among sectors and stocks.

“This is because, as interest rates rise, so does the cost of capital – i.e. the cost of credit to corporates,” he said.

He said this spelled trouble for companies relying on raising capital to run their business and those that were highly geared.

At Amundi, Philippe Ithurbide, global head of research, strategy and analysis, and Bastien Drut, head of strategy and economic research, saw December as the most likely time for the FOMC to make its first rate hike.

“But it will stay in very gradual mode and, at the most, tighten by 25 basis points per quarter,” they said.

Robeco’s chief economist Léon Cornelissen said that, if the economic climate remained favourable, the most likely scenario was for the Fed to make a first modest rate hike in December, followed by an explanatory press conference by Yellen.

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